Inside Five Surging Commodity ETFs

Despite the advice of some in the financial media, many investors have continued to embrace exchange-traded commodity products as efficient vehicles for establishing exposure to natural resources. Cash continues to flow into commodity ETFs, which are popular as both diversifying agents within buy-and-hold portfolios and tools for speculating on short-term price movements among more active traders. Regardless of the underlying resource or the strategy implemented, the last few weeks have been very good to commodity ETF investors.

A weakening U.S. dollar and improving outlook for global equity markets have combined to send prices of many natural resources higher. And while correlations between commodity prices and equities have undoubtedly increased in recent years, several have demonstrated exactly why many investors see this asset class as a valuable addition to stock-and-bond portfolios. While nearly every commodity product has gained ground over the last month, some have delivered particularly big gains. Below, we profile five commodity ETFs that have surged since the beginning of September, taking a look under the hood of each fund and examining some of the factors responsible for their impressive rallies [for more ETF insights, sign up for our free ETF newsletter].

Under The Hood: CORN is one of the newest additions to the commodity ETF lineup, and is the only ETP currently offering “pure play” exposure to corn prices through futures contracts. The structure of CORN is different from the rest of the ETPs on this list, in that the fund spreads exposure across three different maturities. CORN is weighted 35% in the second-to-expire futures contract, 30% in the third-to-expire contract, and 35% in the contract expiring in the December following the expiration month of the third-to-expire contract.

What’s Driving CORN: Corn prices have rallied in recent weeks as anxiety over a relatively weak U.S. harvest has spread. Early yields from Midwest farms have seemingly indicated that this year’s haul will come in below expectations, a result of less-than-ideal weather conditions in major corn-growing regions. But international factors have also been pushing corn prices upwards. The U.S. Grains Council said recently that China will likely quintuple corn imports over the next five years as demand for livestock feed surges. And in Russia widespread wildfires forced the implementation of a wheat export ban, a development that rippled throughout the global agricultural commodities markets [also see Grain ETFs Surge After Russia Halts Wheat Exports].

Under The Hood: USO is one of the most popular products in the Oil & Gas ETFdb Category; this fund is designed to track movements of light, sweet crude oil delivered to Cushing, Oklahoma. USO accomplishes that objective by investing in near-month NYMEX oil futures, rolling holdings each month as expiration approaches [see Pipeline Worries Give Oil ETFs A Boost].

What’s Driving USO: The run-up in crude oil prices–which recently broke through the $80 per barrel mark to touch five month highs–has been attributable primarily to the dollar’s weakness against the euro, yen, and other major currencies. That’s because dollar-based commodities (such as oil) become cheaper to investors using other currencies when the greenback slides, spurring additional demand. The spike in USO and other oil funds has some investors concerned, given that the fundamental data doesn’t seem to justify the rally. The Energy Information Administration said this week that U.S. crude inventories are 7% above year-ago levels–and rising. “The fundamental picture for crude was quite bearish,” said The Schork Report. “Put simply, we are producing more crude oil and refining less of it, the textbook definition of oversupply.”

Under The Hood: SGG is an exchange-traded note linked to the Dow Jones-UBS Sugar Subindex, a benchmark consisting of a single futures contract on the commodity of sugar. The Sugar No. 11 contract traded on the ICE is the world benchmark contract for raw sugar trading, and represents 112,000 pounds of the commodity.

What’s Driving SGG: A falling dollar has given sugar prices a boost, and worries of potential supply disruptions in major sugar-producing regions. Monsoons in India, one of the world’s largest sugar producers, have reduced expectations for this year’s harvests, while rains in Brazil have delayed shipments as well. The sugar ETN has also been aided by backwardation in futures markets, as longer-dated contracts are trading at a discount to futures closer to expiration. While there has been some unflattering coverage of the potential headwinds created by contangoed futures markets, downward-sloping curves can act as wind at the back of investors–as has been the case with SGG [see Sugar ETN: Hello Backwardation!].

Under The Hood: GLD is a physically-backed commodity ETF, meaning that the underlying assets of this fund are gold bars stored in secure vaults. The physically-backed structure means that prices of GLD will generally move in unison with spot prices, eliminating the nuances of a futures-based strategy.

What’s Driving GLD: The meteoric rise of gold prices–the yellow metal has touched new highs multiple times in recent weeks–appears to be driven primarily by investor interest in inflationary hedges. As the Federal Reserve appears poised to implement further quantitative easing, the likelihood of additional capital injections that could increase the money supply further has enhanced the appeal of precious metals. Moreover, some policymakers are indicating that they may take steps to push inflation higher. “The Federal Reserve spent the past three decades getting inflation low and keeping it there,” writes Sudeep Reddy. “But as the U.S. economy struggles and flirts with the prospect of deflation, some central bank officials are publicly broaching a controversial idea: lifting inflation above the Fed’s informal target.” [also see how to Play Precious Metals Through Equity ETFs]

Under The Hood: JJT is also structured as an exchange-traded note, linked to an index comprised of a futures contract on the commodity of tin. Tin is widely used as solder in electronics products, creating a link between the price of the commodity and the technology sector [see all the ETFs in the Commodities ETFdb Category].

What’s Driving JJT: The tin ETN has been one of the year’s best performers in any asset class, thanks to a confluence of factors. Tin is approaching a deficit situation, as global demand has outpaced supply of the metal. According to the International Tin Institute, global production will rise only 1.5% this year, compared to an increase of 15% in demand. Tin has also benefited from a weaker U.S. currency, as this metal is priced on the London Metals Exchange in dollars.

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